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5 reasons to buy Rolls-Royce shares – and why I’m not

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A Rolls-Royce employee works on an engine
Image: Rolls-Royce

The Rolls-Royce (LSE: RR) share price has had a bumpy ride over the past year. While it is flat relative to its price a year ago, in the interim it has sunk to 39p and reached as high as 135p. That’s a lot of movement. With Rolls-Royce shares now in penny stock territory, here are five reasons I’d consider buying the company today – and why I have still not decided to purchase just yet.

1. Civil aviation demand is returning

One of the key drivers for the decline in the Rolls-Royce share price since the pandemic began has been its exposure to civil aviation. That isn’t just about selling engines, though that is important. It is also about servicing them. The less planes fly, the more infrequently they need to be serviced – which hurts the company’s revenues and profits.

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Civil aviation demand is in recovery mode in key markets. If that continues, it should improve the outlook for the civil aviation business – and Rolls-Royce shares.

2. The defence business is resilient

Civil aviation is not the only part of Rolls-Royce’s business. Another important revenue stream is its defence division. Last year it accounted for 29% of the company’s total underlying revenue – and it grew.

The growth was 4%, which amid the impact of the pandemic was a solid performance in my view. The defence business also grew its underlying operating profit to £448m – the biggest of any Rolls-Royce division. Defence spending tends to be resilient, and I think last year’s performance helps make that point.

3. Cost cutting should show benefits

Part of the company’s plan last year to combat the impact of falling business was to strip costs out of the business. Last year it reckoned it saved £1bn compared to what it had planned before the pandemic set in. The company is targeting operating costs and capital spend savings of £1.3bn by the end of next year.

That is a large saving and ought to improve the company’s profit margins. One risk, though, is cutting the wrong costs. Reputation is vital to an engineering firm like Rolls-Royce, and if cost cuts lead to lower quality standards, that could damage the company’s future sales.

4. Rolls-Royce shares and cash flow

One concern about the company is its liquidity position. Last year it secured a mammoth £7.3bn of additional liquidity, meaning that coming into this year it had £3.5bn in cash and £5.5bn in undrawn credit facilities.

The company has repeatedly said that it expects to turn cash flow positive in the second half of 2021 – which is the current half. If it is able to do so, investors may focus more on its future income earning potential rather than fret about its liquidity.

5. Falling Rolls-Royce share price

At just 96p, Rolls-Royce shares are now trading at a 25% discount to where they stood in the spring. But arguably the outlook now is more positive than it was then.

I’m not buying Rolls-Royce shares yet

Despite all that, I’m not buying Rolls-Royce shares yet, in the absence of firmer signs of sustained recovery.

The company’s management has underwhelmed me for years. But what most puts me off is the liquidity needs of such a huge industrial operation. Part of last year’s fundraising involved a highly dilutive rights issue. That’s a risk when – not if – the next cyclical crisis comes along.

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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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